JOBS Act OKs Crowdfunding

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In April, President Obama signed into law the Jumpstart Our Business Startups Act, also known as the JOBS Act. The legislation, which won overwhelmingly bipartisan support, makes it easier for small businesses to raise capital and go public (or stay private if they wish). But the section on crowdfunding will not be as liberating for young companies as some had initially hoped.

The law gives so-called emerging growth companies (defined as companies with less than $1 billion in annual revenue or $75 million in market cap) a five-year reprieve from several Securities and Exchange Commission regulations. These companies, for example, will have to provide only two years rather than three years of audited financial statements in advance of an initial public offering. Experts say this and other regulatory breaks will likely encourage more companies to go public. On the flip side, another provision may have the opposite effect, since it raises the number of shareholders that companies can have and still remain private from 500 to 2,000.

The section on crowdfunding allows companies to use online resources to solicit investments from individuals without having to register their shares with the SEC, as long as they raise less than $1 million a year. (The amount that individuals can invest is restricted according to income.) But thanks to an amendment added in the Senate, the intermediaries, or brokers, of these deals and the start-ups seeking capital will have to provide new documentation.

Under the law, the person selling the shares must register as a broker with the SEC and provide a background check on every executive, director, and person who owns more than 20% of the company behind the equity. Such a requirement does not exist in other securities laws, according to Thomas J. Murphy, a partner at McDermott Will & Emery. Brokers must also provide assurance that investors understand the risks associated with investing in fledgling businesses.

The new rules make crowdfunding “far less popular than a lot of people believe,” says Murphy. The SEC has 270 days to come up with related rules to make the change effective.

Despite the strictures, the industry is excited by the prospect that equity-based crowdfunding will be allowed in the United States. Last month, for example, 50 companies established the National Crowdfunding Association, which plans to set up best practices and host a conference this summer.

Until now, entrepreneurs in this country have been largely limited to trading charity donations, movie tickets, T-shirts, and the like for informal financing through social media. Now they can advertise on websites (also called funding portals) to nonaccredited investors.

“It’s a step in the right direction, but hopefully in the future the boundaries will increase a little bit,” says Kevin Berg Grell, a program director at Crowdsourcing .org, which is creating a set of standards for crowdfunding platforms.